governance, political economy, institutional development and economic regulation

Archive for April, 2016

Everyone loves a royal – especially a British royal, even cynics who claim to disdain them. And why not? There is something reassuringly middle class about being born to the good life and yet having to work hard – saying the right things, looking good, being on time, spending hours chatting with complete strangers and still remain in good humour. The job seems perfect for future age, fail safe robots. Till that happens, the Brits have the royal family – all eighteen of them headed by Queen Elizabeth – who turns 90 next week. Each royal has public duties. Taken together, the family makes itself available for a mind boggling 240 events every month or 8 a day, year in and year out, a burden even the most hardened socialite would wilt under.

The British royals are an especially diligent lot possibly because they draw their legitimacy, not from a divine right to rule, but from Parliament which contracted them for the purpose in 1701. They are funded from estates allotted to them and an annual Sovereign grant of around GBP 35 million (Rs 350 crores)- considerably more than the Rs 30 crores we spend on the office of the President of India. But consider, that per capita income in the UK is twenty times that in India. So in relative terms, the UK outlay is probably tighter than ours for a similar representational institution.

The Duke and Duchess of Cambridge-stooping to capture hearts and minds. Photo credit: rediff.com

The British royals have changed with the times. The stiff upper lip is going. Princess Diana’s inimitable compassion and common touch are now the norm. More significantly, male primogeniture- the gender insensitive British royal practice, whereby a male child always got precedence in succession was ended in 2013 by an Act of the British Parliament.

In comparison, Indian royals somehow never managed to make the transition from being rulers to becoming representatives of the new Indian state. Possibly they failed to brand themselves for the new India. The people’s movement character of the independence struggle, crafted by Mahatma Gandhi, discredited the royals further, as remote, effete relics and toddies of colonialism. Independent India went further. It sought and obtained, the surrender of their sovereignty to the India State in 1949. In 1971 the Indian Parliament abolished their titles and privy purses – pensions to which the erstwhile royals were contractually entitled under the 1949 settlement.

Very few Indian royals managed to remain politically relevant. The Scindias of Gwalior stand out as exceptions who straddle the two main national political parties. Jammu and Kashmir royals and currently the Patiala royals also remain politically alive. But the other significant royals – think Hyderabad, Mysore, Baroda, Bhopal, Indore, Udaipur, Travancore, Kota, Bharatpur, Bikaner, Jaipur, Jodhpur and Cochin- have faded from public memory and affection. In South Asia, Bhutan’s royals stand out as proactive modernisers – British style. Nepal royals, in contrast, have succumbed to democracies march- much like in India.

You can abolish a royal by fiat but you can’t legislate royalty away. If you destroy traditional elites, new elites spring up, because they serve a social purpose, as glue, to bind society together, even in a democratic polity. The US has the Kennedys and the Bush family. In India, the Nehru-Gandhi family endures and inheriting a political legacy is pervasive. In 2011, 29% of the Members of Parliament were from established political families. But it is debatable whether these “political royals” have the affection of the people. It is telling that Amma, Didi and Bhenji- immensely popular in their areas – are all “Marlboro” women – who have built their political eminence not inherited it.

The 2016 Padma Awardees: Photo credit: masala.com

But the real royals of independent India are movie stars, cricketers and the owners of big business- all fiercely competitive and determined to succeed against all odds. The Kapoors of Bollywood – traditional royals mix shoulders with new royalty- the Bachchans, the string of bigger than life “Khans” and Priyanka Chopra- who got a Padma award yesterday. We have an entire locker room of cricketing royalty, of which Mahender Singh Dhoni and now Virat Kohli are the most recent. Star struck business honchos abound. These “new royals” inhabit an interlocking and sometimes toxic world, of business, cricket and movies.

William and Kate – the Duke and Duchess of Cambridge, in line to succeed to the British throne, are of this generation of competitive royals. It is not surprising then, that they chose to schmooze with the new royals of Mumbai in their search for creating “new” Indian memories on their recent visit.

Tragically however, Mumbai’s mojo has yet to infuse Delhi, which remains near colonial. Never mind the eye balls you may draw; the advertising revenue riding on you or the name recognition you command. If you did not become a bureaucrat by age 25 and if you are not in politics, it is unlikely that the government will ever select you to serve the nation in a representational position – as Governor of an Indian state or as an Ambassador overseas. Incidentally, both positions entitle you to fly the tricolour. And so the wealth of available talent — academic, artistic, scientific, professional and entrepreneurial, is ignored. Is it surprising then that government is so stiflingly insular and non-competitive, quite out of keeping with the mood of the nation? Imagine our dated we are. The website of the British monarchy is at pains to inform you how much is spent on the Royal Family. The website of the office of our President is silent on this information and since Parliament does not vote to approve these expenses they are hard to come by. President Mukherjee has done more than most to open up the premises. But the institutional culture is forbidding.

The Padma awards, announced annually are our only mechanism of recognizing exceptional civilian personal merit and national service. These serve the purpose of one-off recognition. But independent and demonstrated talent should be associated more routinely, at every level of government, to leverage experience, build capacity and kindle the spirit of innovation.

Multilateral agencies, including the United Nations, are adept at co-opting celebrities to helm good works and campaigns. The British use their royals very effectively for showing the flag. Why not use our new royals similarly by vacating sarkari space for them? Give Padma awards to recognize long and meritorious service in official and public life. Give Governorships and Ambassadorial assignments to those who distinguish themselves in real life and wish to step out temporarily to serve the nation directly. You would be surprised at the power of incentives to change things around.

Which of us does not enjoy pulling down the high and mighty? And the thrill is even sharper if these are people who may have breached laws whilst rising to dizzy heights. And so it was with the recent Panama Papers leak which opens a window into the morbid financial gymnastics of the amoral, global elite. There are five hundred Indians also in the list. But no “A” team players have yet been disclosed. Of course there is considerable overlay between unaccounted money and simply “smart” money which is avoiding not evading tax- the former is illegal but the latter – well it is just good financial management. The Panama data leak does not sift out the latter.

The scale of dirty money

photo credit: gizmodo.com

Global Financial Integrity (GFI) – a United States-based entity, which tracks and campaigns against black money – ranks India fourth out of 149 developing countries, after China, Russia and Mexico, on the basis of the volume of illicit outflows. But this metric is fuzzy. It relates outflows to the size of individual economies and consequently fails to reflect the severity of the problem in each country.

Conflating the GFI data on illicit flows with the World Bank data on GDP at current market prices results in a more useful metric. The average annual illicit outflows as a proportion of GDP for India, according to this metric, was 2.7 per cent over the period 2004 to 2013. Within the BRICS countries cluster, South Africa was at a whopping 23 per cent, followed by Russia at 5.6 per cent. Brazil was the lowest at 0.9 per cent, with China the second lowest at 1.8 per cent.

Out of the other large developing economies, illicit outflows out of Malaysia stood at a worrisome 14.1 per cent of GDP, Thailand at 5 per cent, Mexico at 4.5 per cent, Nigeria at 4.1 per cent and Indonesia at 2.1 per cent. In South Asia, Bangladesh is the leader with illicit outflows at 4.2 per cent of GDP, followed by Nepal at 3.1 per cent and Pakistan at a low 0.1 per cent.

Dirty money links

So, how do illicit outflows, tax evasion, corruption and crime link up? Simply put illicit flows legitimize the proceeds of any of these activities. In the hawala transfer route, an individual or entity, resident in India, desiring to transfer dirty money overseas, makes a payment in cash in India to a hawala agent whilst a designated counter-party overseas gets paid in foreign exchange.

The source of the cash in India could be from income on which tax has not been paid or the proceeds of crime, including corruption. The foreign exchange overseas could be similarly sourced from corruption, crime or from Indians remitting money home (remittance of invisibles, including by overseas Indians of their earnings, was around $223 billion in 2013). Remittances through hawala get a better exchange rate than those via bank transfers. Foreign exchange overseas could also be the proceeds from under-invoicing Indian exports with part payment being made by the foreign importer to an overseas account related to the exporter.

Such illegal caches of foreign exchange overseas can be legitimated by bringing them back to India by over-invoicing Indian exports. Such funds can also be masked as foreign portfolio investments from foreign jurisdictions where obscuring the ownership of funds is a fine art, as in Panama. GFI estimates that under and over invoicing of trade flows accounts for 83 per cent of global illicit outflows. Usually a combination of several illicit transfer mechanisms may be used to obscure and mask the direction and ownership of the net flows.

The drivers of dirty money

Crime, corruption and the ability to avoid tax are all the outcome of poor governance aided by low levels of financial intermediation and digitization in the economy. Identifying the real ownership of bank transactions using biometric tracers, reducing cash transactions, embedded red flags and alerts which identify and monitor irrational transactions and sniff out a mismatch between income and consumption or income and savings, are standard tools for clamping down on the extent of black money. But we have started down this path only very recently.

Till the 1990s, when India had a chronically precarious balance of payments, the loss of foreign exchange through illicit transfers was a major concern. Today with foreign reserves at around one year of imports this is less so. But the loss of potential tax revenue hits us hard. Assume the value of tax lost on illicit outflows of $83 billion at a conservative 30 per cent or $24 billion per year. This equals around one-fourth of the average fiscal deficit during the period 2010 to 2013.

Lost tax is just one of the problems associated with dirty money. Other downsides are less tangible. Strong political and business interests get entrenched which obstruct enhanced transparency, the reduction of discretionary administrative powers and systematically subvert the formal governance systems and the informal norms which bind society.

Where this happens over a period of time, societal norms shift towards a new normal which actively subverts the rule of law. Prolonged conflict creates a similar loss of cultural and social capital. Government loses credibility as the provider of security and the arbiter of equity and fairness. Citizens look to informal structures like caste, clan or even professional alliances for social support.
Triangulating the evidence

Can we substantiate this link between poor governance and enhanced illicit outflows? The World Bank’s Worldwide Governance Indicators (WGI) provide a ready index which maps six drivers of good governance across multiple data sources. For our purposes we look at two of these – Rule of Law and Control of Corruption. A close and negative correspondence between illicit outflows and the country WGI score can validate both the WGI and the GFI methodologies. High illicit outflows should correspond with a low WGI score.

The WGI ranks Brazil, Malaysia, South Africa and Thailand high on both upholding the rule of law and exercising control of corruption. India edges in only into the Rule of Law category in this ranking. But good performance in the WGI has not helped Malaysia, South Africa and Thailand curb illicit flows which are high, relative to GDP. In comparison, China and India with lower ratings in the WGI have far lower illicit outflows relative to GDP.

Similarly, Pakistan and Indonesia have minimal illicit outflows relative to GDP but score very low in the WGI index. The bottom line is that either the GFI assessments need to be improved or that good governance- at least as it is measured to day needs to be reviewed.
The trend going forward

GFI estimates that the aggregate outflow of illicit money for the set of 149 countries grew at 6.5 per cent per annum during the period 2004-2013 – more than double the rate of economic growth. This is worrisome because it illustrates a looser than desirable link between growth and tax revenues. If economic growth is leaky and does not boost tax revenues in developing countries, achieving social protection and human development targets can be severely compromised. Is India sliding down this slippery slope?

In India, illicit outflows more than doubled overnight from $29 billion in 2009 to $70 billion in 2010. During the period 2010 to 2013 – the latest year for which data is available – it averaged $83 billion per year or around 4 per cent of GDP. This period coincides with the second term of the United Progressive Alliance government, which was marked by serial scams in telecom and coal. But whilst it is tempting to deduce a causal relationship between the two, this is difficult to substantiate.

Better tools can help

What we do know is that we need better tools to monitor, in real decision time, the origin, magnitude and direction of illicit outflows, which are a vital red flag for poor governance. Achieving this is closely linked to professionalizing the government and rapidly digitizing the economy and government processes. We are doing far more on the latter, than on the former. This could be a costly and careless error. Till advanced robotics and artificial intelligence kick in sometime around 2030, the effectiveness of government servants will continue to matter

The curious case of Uttarakhand (a small hill state in north India) shows that getting elected to political office confers powers but no responsibilities.

The otherwise placid, hilly paradise was rocked by frenzied politicking in end March, as Congress dissidents lit a fire under their own government, even as forest fires lit to clear shed pine leaves gusted up clouds of carbon and heat. Tellingly, citizens were more concerned with managing the forest fires than the fallout of the political shenanigans.

Photo credit: disaster-report.com

The Harish Rawat-led Congress government still has one year to go. But it fell, because former chief minister Vijay Bahuguna and Mr Rawat’s ex-buddy from Garhwal, Harak Singh Rawat, and seven others pulled the plug on it. Their timing was cannily disruptive since the annual budget could not be approved — politically effective but irresponsible from a citizen’s viewpoint.

Triple political no-balls

What followed was a comedy of high-level bungling. The Speaker, Govind Singh Kunjwal, disqualified the dissident Congressmen the anti-defection legislation for voting against the government. But it is alleged that he did so only after the President of India had already put him and the state Legislative Assembly under suspended animation by dismissing the government.

Also, subsequent to the budget approval snafu, governor Krishan Kant Paul had already directed on March 18 that the state government prove its majority on the floor of the House on March 28. Why then did the President of India (read the Union government) scramble to dismiss the government on March 27, just a day before the vote of confidence?

The Congress approached the Nainital high court against the dismissal of their government. The honourable single-judge ordered on March 29, somewhat unusually, that the Congress test its numbers in the House on March 31 even though the Legislative Assembly had been suspended by the President of India. Expectedly, this order was stayed on appeal by a division bench of the court.

Politically motivated manipulation of constitutional powers is not new. But consider how low representative democracy has fallen and how remote politics has become from the people who chose to remain indifferent to the political machinations. It was not always like this.

photo credit: tribuneindia.com

Leading up to November 2000, when the state was formed, the mood was upbeat and passions inflamed. The hilly areas of Garhwal and Kumaon had revolted against the allegedly quasi-colonial rule from Lucknow — the erstwhile city of nawabs, sheermal, galawati kebabs and the capital of Uttar Pradesh. Cut to 2016, and the dismissal of a duly elected government evokes no popular response at all beyond gossip at nukkad teashops. Apparently, the average citizen gets galvanised politically only when it is time to vote.

Dysfunctional inner-party governance

Consider also how dysfunctional our political parties are. A significant section — more than a quarter of the Congress MLAs — could not resolve their grievances through inner-party governance systems and chose to create a constitutional crisis to hit back at their party. They did not act out of high moral principles. Nor were there difference with the party around policy, legislation or programmes. Their rebellion was borne out of perceived insufficient recognition by the party of their merit, effort and political standing. Equally, it was irresponsible of the Congress, to ignore the growing dissidence, secure in the belief that the anti-defection legislation could contain dissidence and that there was still one more year before citizens could vote to call it to account.

Sadly, the five-yearly spells of public accountability do not protect citizens sufficiently from irresponsible governments. Can we do better?

Power to recall non performing MLAs

photo credit: English.pradesh18.com

Being empowered to recall recalcitrant public representatives can make public representatives responsive to citizens. But Indian voters do not have this power, unlike in North America and Switzerland.

Technological improvements can help. Biometric identification can cheaply and correctly verify discontented voters who could digitally communicate their intent to recall, thereby triggering a re-election. The “Save the Net” campaign last year and subsequently supporters of Facebook/Internet.org, flooded Telecom Regulatory Authority of India with electronic messages. Voters could similarly message the Election Commission.

Devolve to dilute the zero-sum game of centralized politics

A second option to hold politicians to account is to devolve political office and powers closer to where voters live so that people can actively participate in overseeing an elected politician. The constitutional provisions have existed since 1992, but they have never been implemented in good faith and with full earnestness. Despite the rhetoric, there is little political appetite to let go of centralised powers in the Union and the state governments — both of which function remotely from people.

Our centralised, political ecosystem and architecture have created sticky political interests at the national and the state level.

Rarely does a village-level politician graduate to politics at the state level and even less so to the national level. The India-Bharat class divide exists even in politics.

True to their class ethic, state-level politicians perversely prefer to lose power to an opposing party, in the hope that it would come back to them one day, rather than see power trickle away permanently down to local levels. Consider that the consequence of a state government being dismissed is not the empowerment of local governments, to pick up the slack and fill the vacuum, but instead power is sucked back to Delhi where all state-level politicians aspire to work.

Would the Uttarakhand Congress dissidents have been as ready to rebel and trigger the dismissal of their government if the consequences were that elected leaders at the town and village levels would get vested with the executive powers of erstwhile state ministers and carry on working? Consider also whether the Union government would have been as willing a participant in the dismissal game, if the consequences meant executive powers being transferred lower rather than to the national level.

A chief minister under siege from his own party. photo credit: indianexpress.com

Petty palace politics and dodgy moves will continue to blight political stability and retard effective executive action, unless we rejig the institutional structure to generate political incentives. Citizens must be able to hold governments to account in real time.

Weird as it may sound, despite the rhetoric around innovation and private entrepreneurship being key for growth, this is not the consistent message emanating from government policy and regulations. Here are three examples.

Ideological neutrality versus enlarging access to the internet

First, consider that TRAI caved-in, in February 2016 to the “shrill voices” demanding that Facebook/Internet.org be stopped from offering free basic (limited) internet. The wooly thinking behind this decision was that Facebook- a deep pocket player- could thereby lure users to the Free Basics site- dubbed by activists as a walled garden, from which there would be no escape. Customers would be so entranced by the scented garden, that they would never wish to explore anything beyond the limited products on display within. This may have pleased Facebook- the description of Free Basics closely matching what heaven must be like- but they upped stakes and left.

Foreign companies make easy targets

Most likely Free Basics, a foreign venture, was just an easy target. TRAI probably played to the home grown, software industry – represented by NASSCOM- which was up in arms against the foreign interloper. But it is the consumer who lost out- particularly those at the margin of attaining internet access. These millions could have been in a free walled garden. Today they continue to wander through the dust of an internet less but limitless, real desert.

The economic cost of banning access to free basic internet

ICRIER, a Delhi based think tank, is assessing the economic cost of not providing internet access through a nineteen state survey. Preliminary assessments show that there is a significant increase in GDP by adding more users to the internet. The, un-confirmed, upper-bound assessment could be an astounding additional GDP growth of around 2.5% if the number of internet users are increased by 16%. This is exactly what Free Basics would have done. But they have been thwarted by rules, which adversely impact competition, jobs and wealth creation via innovation.

Sadly, this is not the only example. Yet another instance of rules which increase the transaction cost of doing business for innovators, rather than reducing it is the new FDI regulations permitting 100% foreign equity in e-commerce market platforms. Whilst the relaxed FDI limit is progressive, the additional constraints it comes with are not. One condition is that no supplier should have more than a 25% share in sales on the platform. Another condition is that the market platform must not influence retail prices.

e-market platforms are not stock exchanges

The government’s conception of an e-commerce platform seems to closely resemble a stock exchange, which is hands off aggregator and facilitator for matching demand and supply. Why then would we need more than one such e- commerce platform – since profits lie in scaling up operations? God forbid if the next step is to specify that the market platform must be co-operatively owned by all the suppliers.

Lip sympathy for bricks and mortar retailers

The underlying concern behind the restrictive concerns seem be that e-commerce market places should not disrupt the business of stand-alone bricks and mortar retailers by offering deep discounts, using private equity funds, to grab market share. True private equity driven scaling up can bankrupt inefficient and under- funded retailers. But isn’t it in the nature of business to remain efficient via disruption? Government needs to concern itself not with the fortunes of individual businesses but the aggregate health of the retail sector- employment and customer services provided. Instead of protecting individual jobs, government must grow the total number of jobs recognizing that innovation- by definition, is disruptive of the status quo.

In any case rules to artificially maintain the status quo are rarely effective. They can be undermined and evaded. That is not the concern. The real concern is the adverse impact, that impractical rules have on the innovation eco-system. Innovators and their financiers, expose themselves to enormous business risk. The last thing they need, as an add-on transaction cost, is the risk from uncertain regulation.

Why extend the broken business eco-system of legacy industries?

There is also the issue of the attracting the wrong kind of innovators and private equity- those who are adept at working within a tightly regulated regime using the nod-wink approach to compliance with rules. This was a key qualification for doing business in India earlier. It should not be allowed to become the norm in e-commerce also.

We acclaim IIT/IIM graduates who are courageous enough to start their own e-business. But why tie their hands behind their backs from the start by forcing them to be dishonest; by requiring them to innovate a business model which will hood wink the law. And what about the potential risk that these illogical regulations may be tightened further. For example, prescription of rigorous tests for a Chinese wall between the e-market platform and the suppliers with respect to shareholding; a ban on inter-company loans from cash rich platform developers to suppliers to avoid the short circuiting of the discount ban by setting up shadow, intermediate whole-sellers between the market platform and the actual suppliers.

Most importantly, the desire to tick the box on allowing 100% FDI in marketing platforms whilst mollifying the lobby of bricks and mortar retailers, has derailed the existing eco-system for innovation in e-commerce. Rather than getting out of their way, the government has ended up increasing the potential nuisance from the new regulations. This is not a healthy environment for promoting innovation.

Remember the boom in private IT and telecom business?

The spectacular IT growth since the 1990s was the result of facilitation rather than intrusive regulation. Similarly, the telecom industry grew exponentially post-2000, because the quality of regulation was light handed and promoted competition rather than intrusive regulation of business processes and pricing of retail services.

Electricity – the limitations of intrusive regulation

In sharp contrast, the electricity supply industry has intrusive cost of service based retail price regulation. The results are before us. Despite three separate schemes, since 2000, to restructure the stressed loans of electricity distribution companies, they still comprise a quarter of the non-performing assets of public sector banks. Whether privatization of electricity distribution in 2000- as was envisaged then- along with liberalization of the energy supply chain, could have had happier results, is in the realm of speculation. But intrusive regulation has not helped one bit in restoring the sectors health.

The consistent lesson is that less government is better governance. This was PM Modi’s rallying principle. One only wishes that he would make someone, who has his ear, responsible for alerting him every time government departs from this golden rule.